Foreign Exchange Reserves Costs

In this article, we are going to discuss the foreign exchange reserves costs. We shall study the costs involved in the forex reserves operations and also some other related details. The foreign exchange reserves enable the government of a country to manipulate the exchange rates in order to provide a positive and encouraging economic environment in the country. The government usually takes measure to stabilize the exchange rates which provides a positive image of the country’s economy. Theoretically, the manipulation of foreign exchange reserves rates can offer the same stability as granted by the gold standards. However in real practice, this has not been all true. Also, the bigger the foreign exchange reserves of a country, the higher is its position in defending itself from the tentative attacks on the domestic currency.

There are some costs involved in the maintenance of large currency reserves, known as the foreign exchange reserves costs. The exchange markets witness fluctuations in currency exchange prices which causes profits and losses in the purchasing capacity of the currency reserves. These fluctuations can also cause huge losses even when there are no currency crises in a country. Continuing with our discussion regarding the costs in foreign exchange reserves, let us consider an example here which shows how market fluctuations have an impact on the Forex reserves costs. It is believed that China has been holding a larger part of the huge US dollar denominated assets. However, the US market has been getting weaker on the exchange markets rates, resulting in a relative loss of wealth which can be termed as the benefits in foreign exchange reserves.

Apart from these fluctuations in exchange rate, the purchasing ability of fiat money comes down on a regular basis because of the devaluation process through inflation. This is the reason why a central bank is required to increase regularly the amount of its reserves to maintain the same power to manipulate exchange rates.

The forex reserves provide a small return in interest. However, this may be less than the reduction in buying capabilities of that currency over the same period of time due to inflation. Thus, we can conclude that the ability of the currency purchasing power is greatly influenced by the fluctuations caused in the market and affecting the foreign exchange reserves costs.